The long view

To truly appreciate the collapse of the American capital markets, let us take the telecommuncations company Metromedia Fiber Network (Pink sheet:MFNXW) as an example.

A year ago its share was trading at $2.50. Today it is hovering around 7 cents. In other words, a $1,000 investment a year ago would now be worth $28.

But if you'd spent the whole $1,000 on beer or soda, and collected the deposits on the bottles, you'd have $50. Conclusion: You might as well, from a strictly financial perspective, sat back and enjoyed yourself rather than invest on Nasdaq.

Given the debacle affeting the telecommunications industry, it is all the more amazing to find that Jack Grubman a leading analyst, who was forced to resign a few days ago from Salomon Smith Barney is getting a $32 million compensation package from his former employer.

In the second half of the roaring '90s, Grubman had major clout on Wall Street. He recommended whole slew of telecoms companies, particularly those with which his bank worked.

The system worked like this: Salomon Smith Barney handled the underwriting business for a tidy sum, and Grubman served as analyst and as consultant for the same companies. He would favorably review the share issue, the firm's management would receive large share packages in the pre-issue stage, the public would lap up the offering, the share would soar and he would earn a handsome bonus.

While the general public flew along with Nasdaq, Grubman et al pocketed hundreds of millions.

And in order to justify these incredible high prices for the companies, they thought up a new "finance theory," according to which the worth of a company was determined not by its future profits, but according to its potential customers, the number of hits on its website, etc. And as they themselves had invested in the same companies, they continued to recommend the telecoms sector even in the thick of its downfall.

How can the errors be corrected? How can managers and analysts be forced to act according to genuine economic interests? How can one clamp a ceiling on salaries? How can corruption, including by rogue analysts, be prevented?

One possibility is to grant incentive packages to managers based on profits or share price not in the quarter to come, but in the long run, say over five years. That would abolish the incentive to inflate figures or swindle, because balance sheets cannot be mis-stated over such long periods of time.